By Roosevelt Institute | 03.16.12

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“We know the startup sector is important, and it is sputtering.” So said Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, at the Conference on Small Business and Entrepreneurship During an Economic Recovery. Although recent employment reports have signaled improvement in the labor market, with the unemployment rate falling to 8.3 percent and jobless claims tumbling, a closer inspection of underlying trends concerning new business creation is troubling. As Lockhart noted, between 1992 and 2005, the rate of new business creation outpaced the rate of exit by about two percentage points, providing a net increase in employment. However, with the onset of the Great Recession, the relationship between these two metrics was overturned. Business failures rose sharply while the rate of establishment fell from 870,000 a year in 2006 to 720,000 in 2010, signaling a reversal in new business and employment trends.

Given the current momentum in the labor market, some question if new business creation is truly vital for the recovery. With established companies currently sitting on record cash reserves worth nearly $2 trillion, it would seem that they already have the resources to reduce unemployment considerably. However, new business creation during and after the recovery must recuperate for more reasons than simply job numbers, even though businesses with fewer than 50 workers are the largest employers in the nation and have consistently led payroll gains during the recovery. Federal Reserve Chairman Ben Bernanke stated that beyond playing an “important role in fueling past recoveries,” new businesses help drive innovation, provide an economic alternative to those facing income instability, and “help sustain the vitality of the neighborhoods” in which they are located. The recovery is not just clawing out of the hole created by the financial crisis of 2008, but rebuilding a new base from which sustained, dynamic, and meaningful employment and economic growth can occur. New business creation therefore remains a crucial component of the economic recovery.

But what tools are likely to affect this positive and sustained momentum? Certainly cyclical unemployment, symptomatic of the Great Recession, is the main contributing factor to the dismal employment situation. However, permanent change in the labor market in the wake of the financial crisis must come in the form of changing its structural inefficiencies. One such change that will reduce unemployment during and after the recession is reforming and simplifying the process of founding a business. Even if one has the necessary capital, the current bureaucratic obligations of formally starting a business are demanding.

Without the services of a lawyer, prospective new business owners must often navigate the red tape of permits, incentives, and regulations of multiple city, state, and federal agencies. Requiring a significant investment of time and effort on the part of the entrepreneur, the current process of establishing a new firm should be made more time efficient. The structural barrier to new businesses created by these regulatory hurdles can and should be fixed — not only for the sake of the recovery, but for future job growth, since these restrictions will not disappear when the recovery ends.

From a simple accounting perspective, “the cost disadvantage on small business in each sector is driven largely, but not entirely, by compliance with environmental regulations and with the federal tax code.” Complying with these regulations is more difficult for smaller businesses because they possess reduced economies of scale relative to larger ones and consequently stretch their human capital thin. This burden is especially severe on small firms in the manufacturing sector, with the estimated cost per employee being 118 percent and 151 percent higher than medium and large-sized firms. Given that manufacturing is currently “supporting first quarter overall growth in the economy ” and “driving the economy forward,” this regulatory strain on new manufacturing businesses relative to larger manufacturing firms may be injuring the momentum manufacturing has provided during the recovery.

Beyond accounting costs, the time costs of setting up a new business cannot be monetized. However, given that new businesses have very limited resources with regards to legal and administrative burdens, there are indirect economic impacts of time and lost productivity due to the multiple tasks required. For instance, a new restaurant owner in New York City who “wants to serve alcohol and have a pool table […] needs no fewer than 11 city permits and licenses.” Determining which agencies he or she must contact, as well as the different permits, incentives, and certifications he or she must complete presents a legal quagmire for entrepreneurs. This difficulty is largely due to the hundreds of new and sometimes contradictory rules agencies issue each year, meaning new business owners are tasked with legal burdens on top of the stresses of establishing a new business.

So how can these structural inefficiencies be remedied? One proposed solution is to create a single location from which all permits and forms for new businesses can be obtained across all local, state, and national agencies. This singular resource will steeply reduce the time commitment of retrieving and returning the forms for entrepreneurs. Given the proliferation of web-based processes and the movement to an Internet society, this one-stop location for new business owners need not be a brick-and-mortar establishment. Instead, it can take the form of a one-stop website, accessible at all times from anywhere.

One model for a one-stop website is New York City’s NYC Business Express. Spearheaded in 2006 by New York City Mayor Michael Bloomberg, NYC Business Express offers “clear, focused content where traditionally there was an overload of information.” Establishing a business was compared to finding “five needles in 35 haystacks” due to the significant number of city, state, and federal regulations and agencies a business owner in New York City must interact with. However, the NYC Business Express website hosts upwards of 20 different city agencies’ permits, incentives, licenses, and payments that can be retrieved online at any time. The website also walks new business owners through the process step by step in a manner customized to the entrepreneur’s line of business. As a result, the previously tedious and deterrent process of establishing a new business in New York City is now compared to someone handing “you the five needles you need and they’re categorized, labeled, and come in a leather-bound carrying case with clear instructions on how to use them.” This time-saving service has led to more than 22,000 accounts being logged on the site as well as cities like Boston, Newark, Portland, and San Francisco, which have reached out to New York City to create similar websites of their own.

The time-based restrictions of establishing a new business are structural inhibitors to new business creation, but sites similar to the successful NYC Business Express can reduce such barriers. Since the tedium suffered by new business owners is nearly universal, these one-stop sites also need to be widespread in order to reduce structural barriers to a significant degree. NYC Business Express is a successful beginning, but time inefficiencies have not been resolved elsewhere. As these one-stop websites spread, they will reduce structural inefficiencies and permanently drive the dynamic process of new business creation that is crucial not only to the recovery, but to all future job growth.

Blake Falk is a Roosevelt Institute | Campus Network member at the University of North Carolina at Chapel Hill where he studies mathematical decision sciences and economics.

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